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Sunday, January 13, 2013

Fed meeting: QE3 has set sail

The Federal Reserve announced aggressive moves to boost the economy Wednesday, sending the stock market sharply higher. The Fed said it would purchase $40 billion a month of mortgage-backed securities to spur economic growth and help reduce unemployment (aka "quantitative easing," "QE" or "large-scale asset purchases.") Unlike like the previous two iterations of bond buying, where the Fed put a limit on the amount of bonds it would purchase, the Fed says it will keep buying the securities until the job market shows substantial improvement.

The central bank also announced that it would continue "Operation Twist", whereby the Fed sells short-term bonds and uses the proceeds to buy longer-term bonds in order to keep longer-term interest rates lower. The combination of QE3 and Operation Twist means that the Fed will be buying $85 billion of bonds each month through the end of the year. Finally, the Fed extended its plan to keep short-term interest rates at record-low levels through mid-2015, from its previous time horizon of the end of 2014.

The purpose of QE, when the Fed goes into the market and buys bonds, is to push down longer term interest rates, encouraging more lending and borrowing, which ultimately should spur new economic growth. At least that's the theory. Critics say it doesn't work, and predict it will lead to inflation down the road.Now that QE is going be with us for a while, here is a handy "QE Cheat Sheet":

How does QE work? In a lecture at George Washington University last March, Federal Reserve Chairman Ben Bernanke explained how QE works. Here's the quick version: Read more...